Sarbanes-Oxley Oversight Board Facing Constitutional Challenge

A group of advocates for free enterprise and limited government that includes former federal independent counsel Kenneth Starr is challenging the constitutionality of the Sarbanes Oxley Act and its provisions that govern the accounting of public companies.

The Free Enterprise Fund of Washington, D.C. filed a constitutional legal challenge to the Public Company Accounting Oversight Board (PCAOB) created by Congress as part of the Sarbanes-Oxley Act, which was enacted in 2002 following a number of corporate scandals,

The SOX Act has been criticized by businesses, including insurers, for imposing new costs on publicly traded U.S. businesses.

The lawsuit claims that although the Sarbanes-Oxley Act purports to make the board a private entity, it delegates to the board vast governmental powers.

The complaint was filed in U.S. District Court for the District of Columbia on Feb. 7.

The complaint alleges that the PCAOB violates the Appointments Clause of the Constitution because it is composed of superior “officers” who need to be appointed by the President (or, alternatively, by heads of executive branch departments) rather than the Securities and Exchange Commission.

The suit’s broader claim is that the PCAOB violates separation of powers principles because its members perform an executive function but are not appointed or removable by the President or any entity within the executive branch. By giving the board unbridled authority to set standards regulating accounting firms and to finance its own operations by charging a fee to public companies, Congress violated the constitutional prohibition on delegating its legislative powers to an entity outside the legislative branch, according to the suit.

The SOX board being criticized is empowered to enact and enforce standards governing how public-company audits must be carried out and to impose sanctions on accounting firms of up to $2 million for inadvertent violations of the board’s standards and up to $15 million for knowing or reckless ones.

The complaint seeks an order declaring unconstitutional the provisions of the Sarbanes-Oxley Act creating and empowering the board and enjoining it and its members from carrying out any of the powers delegated to them by the SOX Act.

“It is now clear that the costly regulatory burdens imposed by this legislation absolutely outweigh its benefits,” commented Mallory Factor, chairman of the Free Enterprise Fund, citing a recent University of Rochester study he said concluded that the total effect of Sarbanes-Oxley has reduced the stock value of American companies by $1.4 trillion dollars.

“The PCAOB and the Sarbanes-Oxley Act raise unconstitutional barriers to needed liquidity, discourage entrepreneurship and innovation, and hinder U.S. competitiveness by denying access to needed capital. The high cost of compliance that disproportionately affects smaller public companies is having long-term exponential negative implications for our economy,” Factor added.

The originating plaintiffs are the Free Enterprise Fund and Brad Beckstead, managing partner of accounting firm Beckstead and Watts, LLP, which has a history of serving small publicly-traded and development-stage companies. The legal effort, led by the Free Enterprise Fund, will be conducted by a panel of legal experts, including Kenneth Starr, former independent counsel who investigated the Whitewater and Monica Lewinsky scandals during President Bill Clinton’s terms, and is with Pepperdine University; Viet D. Dinh, professor of law at Georgetown University; Michael A. Carvin, partner, Jones Day; and Hans Bader, counsel, Competitive Enterprise Institute.

Beckstead, managing partner of accounting firm Beckstead and Watts, LLP, said his firm has become a casualty of a “government agency run amuck” under the SOX statute. “We can no longer serve the needs of small publicly-traded companies while continually having to focus our time and monetary resources answering to the incessant demands of an unaccountable PCAOB. The ultimate consequence of the PCAOB actions will be to put small public companies out of business, force them to de-list, or take their public offerings offshore to Europe and Asia,” he maintained.

Free Enterprise leaders argue that there is a better way to achieve the goals of SOX other than empowering the PCAOB.

“The critical goals of solid internal controls and transparent financial reporting are better achieved by a free and unfettered capital market rather than by burdensome regulation,” said Factor. “Enforcement efforts should focus on aggressive prosecution of bad actors under existing anti-fraud laws rather than imposing costly and largely ineffective procedural requirements on all public companies.”